The Securities and Exchange Commission and the Financial Industry Regulatory Authority collectively fined a broker-dealer over US $6.1 million for not having an anti-money laundering program reasonably designed to detect and report suspicious activities, and not reporting a number of questionable transactions. Separately, during a House of Representatives’ committee appearance, the co-heads of the SEC’s Division of Enforcement bemoaned recent time restrictions imposed on enforcement actions for disgorgement, while the SEC itself launched an initial coin offering that purposely was a fraud – but it was a very good fraud! As a result, the following matters are covered in this week’s edition of Bridging the Week:

SEC and FINRA Collectively Fine Broker-Dealer Over US $6.1 Million for AML Violations (includes Compliance Weeds);

Bridging the Week is not scheduled to publish on May 28; the next scheduled edition is June 4.

Video Version:

Article Version:

Briefly:

SEC and FINRA Collectively Fine Broker-Dealer Over US $6.1 Million for AML Violations: The Industrial and Commercial Bank of China Financial Services agreed to remit a fine of US $5.3 million to the Financial Industry Regulatory Authority in response to allegations that, from January 2013 through at least September 2015, it failed to maintain an anti-money laundering program “reasonably designed” to detect and cause the reporting of suspicions activities. ICBCFS also agreed to pay a fine of US $860,000 to the Securities and Exchange Commission for allegedly not filing suspicious activity reports with the Financial Crimes Enforcement Network of the US Department of Treasury despite referring information regarding numerous suspicious transactions involving penny stocks to one of its correspondent brokers, Chardan Capital Markets, LLC, from October 2013 through June 2014. The SEC additionally claimed that ICBCFS did not promptly produce required records when requested by the SEC, in connection with the Commission’s investigation into this matter.

According to FINRA, prior to January 2013, ICBCFS initiated a new business involving clearing and settling equity transactions. As a result, ICBCFS commenced carrying and clearing many correspondent broker-dealers, including Chardan, and “thousands of new introduced customers.” Many of these customers bought and sold penny stocks. From January 2013 through at least September 2015, ICBCFS cleared and settled the liquidation of in excess of 33 billion shares of penny stocks

Notwithstanding, said FINRA, prior t0 2014, ICBCFS did not have surveillance reports to monitor potentially suspicious low-priced stock liquidations, and where there were reports, the firm’s procedures did not require employees to document such review. As a result, claimed FINRA, during the relevant time, ICBCFS failed to identify many possibly suspicious penny stock liquidations that may have required SAR filings. The firm also failed to conduct “appropriate” independent testing of its AML program in violation of FINRA rules.

The SEC claimed that from at least October 2013 through June 2014, ICBCFS contacted Chardan regarding suspicious activities by its customers involving penny stocks. However, afterwards, ICBCFS never filed suspicious activity reports with FinCEN. Moreover, during the SEC’s investigations of Chardan, ICBCFS failed promptly to produce certain emails as requested, claimed the SEC.

As part of its settlement with FINRA, ICBCFS agreed to utilize an independent consultant to evaluate and make recommendations to upgrade its AML program related to monitoring transactions involving low-priced securities

Separately, the SEC brought and settled charges against Chardan for not conducing an adequate review of large-scale penny stock liquidations through seven customer accounts from at least October 2013 through June 2014 and for not investigating a number of red flags regarding such trading, including numerous regulatory inquiries after May 2014 regarding certain securities that certain of its customers traded. Likewise, the SEC commenced and resolved charges against Jerard Basmagy, Chardan’s chief compliance officer and AML officer from at least 2008 through early 2017, for aiding and abetting Chardan’s alleged violations. Chardan agreed to pay a fine of US $1 million to resolve the SEC’s charges, while Mr. Basmagy agreed to pay a fine of US $15,000.

Compliance Weeds: Applicable law and rules of the FinCEN require broker-dealers and other covered financial institutions (banks, Commodity Futures Trading Commission-registered futures commission merchants and introducing brokers, and SEC-registered mutual funds) to file a SAR with FinCEN in response to transactions or patterns of transactions involving at least US $5,000, which a covered entity “knows, suspects, or has reason to suspect” involve funds derived from illegal activity; have no business or apparent lawful purpose; are designed to evade applicable law; or utilize the institution for criminal activity.

According to FinCEN, SARs may also be required to be filed for certain cyber events. (Click here for background in the article “FinCEN Issues Advisory Saying Cyber Attacks May Be Required to Be Reported Through SARs” in the October 30, 2016 edition of Bridging the Week.)

In 2014, FINRA fined Brown Brothers Harriman & Co. US $8 million for failing to file SARs in connection with similar activity involving penny stocks as alleged to be at issue in the Meyers Associates administrative proceeding. In Brown Brothers, FINRA also fined and suspended the firm’s global anti-money laundering compliance officer for his alleged role in the firm’s alleged misconduct. (Click here for details in the article “FINRA Says Brown Brothers Harriman Had an Unsatisfactory Anti-Money Laundering Program; Sanctions Firm and Former Global AML Compliance Officer,” in the February 10, 2014 edition of Bridging the Week.)

More recently, Aegis Capital Corporation, a registered broker-dealer, agreed to resolve separate charges brought by the SEC and FINRA that, from at least January 2012 through April 2014, it failed to file suspicious activity reports with FinCEN in connection with transactions that potentially also involved market manipulation of low-priced securities. Aegis settled its SEC matter by agreeing to pay a fine of US $750,000 and its FINRA action by agreeing to pay a fine of US $550,000. Contemporaneously, Kevin McKenna, the firm’s anti-money laundering compliance officer from June 2012 through June 2013, also agreed to resolve SEC charges related to Aegis’s SEC enforcement action. Mr. McKenna consented to pay a penalty of US $20,000 and not serve as a compliance officer or an AML compliance officer of a broker-dealer or similar organization for at least 18 months. (Click here for background in the article “Broker-Dealer, CEO and AML Compliance Officer Settle SEC Charges for Not Filing Suspicious Activity Reports in Response to Red Flags” in the April 1, 2018 edition of Bridging the Week.)

Covered financial institutions should continually monitor transactions they facilitate; ensure they maintain and follow written procedures to identify and evaluate red flags of suspicious activities; and file SARs with FinCEN when appropriate. (Click here for a helpful overview of anti-money laundering requirements for broker-dealers, including SAR requirements. Click here for a similarly helpful compilation of AML resources for members of the National Futures Association.)

SEC Enforcement Co-Heads Bemoan Supreme Court’s Imposition of 5-Year Statute of Limitations on Disgorgement; Commission Separately Issues Fake ICO: In a joint appearance before the House of Representatives’ Committee on Financial Services, Securities and Exchange Commission co-directors of Enforcement, Stephanie Avakian and Steven Peiken, said that the Supreme Court’s 2017 decision requiring the Commission to commence enforcement actions seeking disgorgement within five years after the date of alleged wrongdoing potentially will “severely limit the recovery available to harmed investors.” This is because, said the co-directors, some “egregious fraud cases” are well hidden and may not be uncovered until many years after the fraud has been committed.

The Supreme Court made its ruling in a case against Charles Kokesh who was accused by the SEC in 2009 of misappropriating US $34.9 million in connection with two investment adviser firms he operated from 1995 to 2009. The co-directors noted that, because of the Supreme Court’s ruling, Mr. Kokesh, who was found liable for defrauding his advisory clients of US $35 million, was able to keep more than 80 percent of the money he stole. (Click here for background in the article “Diamonds May Be Forever, but US Supreme Court Rules SEC Ability to Seek Disgorgement Limited to Five Years” in the June 11, 2017 edition of Bridging the Week.)

In their presentation before the House Finance Committee, Ms. Avakian and Mr. Peiken also discussed the Division’s enforcement activities involving cryptocurrencies. Separately last week, the SEC issued a much-publicized fake initial coin offering of its own involving HoweyCoins. Potential investors signing up for the ICO were greeted by a warning “If You Responded to an Investment Offer Like This, You Could Have Been Scammed – HoweyCoins Are Completely Fake.” The SEC listed a number of common characteristics of bogus ICOs, including claims of high, guaranteed returns; celebrity endorsements; suggestions that the ICO tokens will trade on SEC-compliant exchanges, when the referenced platforms are not registered or SEC-regulated; and encouragement to purchase ICO tokens with credit cards.

Unrelatedly, the New York Department of Financial Services granted its fifth Bitlicense to Genesis Global Trading Inc., an SEC-registered broker-dealer and a member of the Financial Industry Regulatory Authority. (Click here for details.)

My View: Kudos to the SEC for devising its HoweyCoin white paper and website. It is an exceptionally creative effort by the SEC to communicate the danger of investing in potentially fraudulent fundraising activities. Hopefully, when developing these fake offering materials, the SEC recognized that – despite the issues with many bogus ICOs – there is great appetite by other than the most sophisticated investors for simplified disclosure materials and by at least some entrepreneurs for a quicker and more efficient means to raise capital. Hopefully, the SEC will leverage this knowledge to help create new offering mechanisms to support legitimate persons and their fundraising activities, as well as investor demand.

Compliance Weeds: NY’s BitLicense regime, adopted in 2015, established a licensing requirement for all financial intermediaries who engage in a virtual currency business activity from New York or to a NY resident. What constitutes a virtual currency business activity is broadly defined and includes (1) receiving virtual currency for transmission or transmitting virtual currency except where the transaction is for non-financial purposes and only involves a nominal amount; (2) storing or holding virtual currency for others; (3) buying and selling virtual currency as a customer business; (4) engaging as a customer business in the conversion or exchange of (a) fiat currency or other value into virtual currency, (b) virtual currency into fiat currency or other value, or (c) one form of virtual currency into another form of virtual currency; or (5) controlling, administering or issuing a virtual currency.

In general, under NY’s Bitlicense regime, all financial intermediaries engaging in a virtual currency business must apply and obtain a so-called BitLicense, and maintain certain minimum standards and programs to help ensure customer protection, cybersecurity and anti-money laundering compliance.

Earlier this year, NY DFS imposed new requirements on all state-licensed virtual currency businesses to help avoid fraud and market manipulation. Specifically, such businesses, including those additionally licensed as money transmitters in the state, must put in place measures “to effectively detect, prevent, and respond to fraud, attempted fraud, and similar wrongdoing,” including manipulation.

(Click here for more background in the article “NYS Financial Services Regulator Ups the Obligations of State-Licensed Virtual Currency Entities” in the February 11, 2018 edition of Bridging the Week.)

More Briefly:

California Federal Court Judge on His Own Certifies Recent Order Adverse to CFTC for Appeal: The California trial court that recently dismissed an enforcement action by the Commodity Futures Trading Commission against Monex Deposit Company and other defendants for alleged fraud in connection with their financed sale of precious metals to retail persons certified its own decision for appeal on its own motion, not on any motion filed by the Commission. This authorizes the CFTC to appeal its loss, although it still must file an amended complaint responsive to the court’s May 1 decision by end of the month if it wants. The court indicated in entering its order for “interlocutory appeal” that its decision dismissing the CFTC’s complaint involved “a controlling question of law as to which there is substantial ground for a difference of opinion.” In its May 1 ruling, the California court held that:
​

actual delivery of precious metals in financed transactions to retail persons falls outside the CFTC’s authority when ownership of real metals is legally transferred to such persons within 28 days – the so-called “Actual Delivery Exception” – even if the seller retains control over the commodities because of the financing beyond 28 days; and

the CFTC cannot use the prohibition against persons engaging in any manipulative or deceptive device or contrivance in connection with the sale of any commodity in interstate commerce enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act to prosecute acts of purported fraud except in instances of fraud‑based market manipulation.

(Click here for details in the article “California Federal Court Dismissal of CFTC Monex Enforcement Action Upsets Stable Legal Theories” in the May 6, 2018 edition of Bridging the Week.)

Supreme Court Declines to Hear Appeal by the First Person Convicted Under New Anti-Spoofing Law: The United States Supreme Court declined to hear an appeal by Michael Coscia, the first individual convicted of spoofing under an amendment to applicable law adopted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. In February, Mr. Coscia requested the US Supreme Court overturn his conviction. (Click here for details in the article “First Trader Criminally Convicted for Spoofing Requests Supreme Court Overturn Decision, Claims Applicable Statute Is Unconstitutionally Vague” in the February 11, 2018 edition of Bridging the Week.)

Separately, Rostin Behnam, a Commissioner of the Commodity Futures Trading Commission noted that spoofing “can be challenging to prove” because it requires evidence demonstrating a defendant’s intent to cancel a bid or offer prior to execution. He said this is the case because many orders may not be filled or be cancelled for “legitimate reasons.” As a result, “a pattern alone may not evince misconduct.” He suggested this contrasts with a finding that a registrant failed to supervise, which does not require intent. For this offense, the Commission need only show that a registrant’s supervisory system was “generally inadequate” or the registrant failed to “perform its supervisory duties diligently.”

National Stock Exchange of India Granted Part 30 Relief: The Commodity Futures Trading Commission has extended its Part 30 exemption program to the National Stock Exchange of India. Under the CFTC’s order, NSE may designate a member to accept US customers funds to trade futures and options contracts on NSE without registering as a futures commission merchant.

Compliance Weeds: Ordinarily, all entities that solicit orders from US persons or handle funds in connection with futures and options must be registered with the Commodity Futures Trading Commission in some capacity (typically as a futures commission merchant or commodity pool operator if they handle customer transactions and funds) or as an introducing broker or commodity trading advisor (if they solely handle customer transactions). Part 30 of the CFTC’s rules provides a number of exemptions for non-US-based entities to deal with US persons in connection with foreign futures and options contracts. One exemption – under CFTC Rule 30.5 – applies to any entity other than one that might otherwise be required to register as an FCM, while another – under CFTC rule 30.10 – applies to an entity that would otherwise be required to register as an FCM. A Rule 30.10 exemption typically requires the involvement of a local regulator as part of the exemption request process. (Click here to access the relevant regulations, and here for a CFTC summary of applicable requirements.) Another CFTC rule authorizes certain entities outside the United States exempted from registration as an FCM under CFTC Rule 30.10 to execute US futures and options for certain institutional customers to be carried at a registered FCM subject to strict conditions. (Click here to access CFTC Rule 3.10(c)(4).)

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of May 19, 2018. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made. Views of the author may not necessarily reflect views of Katten Muchin or any of its partners or other employees.

Archives

ABOUT GARY DEWAAL

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.